Co-op Owner Wins Casualty Loss Appeal

I really enjoy reading the appeals of Tax Court decisions that I have blogged. I especially like decision where the Circuit sets the Tax Court straight and rules for the taxpayer, like the recent Second Circuit decision in the case of Christina Alphonso. Ms. Alphonso was a tenant stockholder in a cooperative apartment complex called Castle Village. It is in Manhattan, not far from the George Washington Bridge with a great view of the Hudson River. The complex had a retaining wall which collapsed spreading dirt, rocks and other debris on the road below. The owners of Castle Village were assessed to pay for repairs. Among them was Ms. Alphonso whose share was over $26,000.

It sure seemed like a deductible casualty loss to me. The IRS did have an argument that the collapse was due to gradual erosion, but that is not what they pursued. They instead attacked the deduction based on the nature of Ms. Alphonso's property interest. Obviously there would not have been a problem if Ms. Alphonso had outright owned the building. The IRS even conceded that there would not have been a problem if her apartment had been a condominium. Castle Village, however, is a cooperative. The Court explained:

Under New York law, “[t]he ownership interest of a tenant-shareholder in a co-operative apartment is sui generis.” The interest in a cooperative apartment “is represented by shares of stock, which are personal property, yet in reality what is owned is not an interest in an ongoing business enterprise, but instead a right to possess real property.”

A co-op owner owns stock in a corporation that owns the property and by virtue of the stock ownership has a right to occupy one of the apartments in accordance with a proprietary lease. The IRS was trying to argue that there was not sufficient interest in the common areas to allow for a casualty loss. The Tax Court bought it, but the Second Circuit does not agree:

In sum, as augmented by the appended House Rules, the Proprietary Lease in this case, unlike the lease at issue in West, gave a defined group of persons--building residents such as Alphonso--the right to use the Castle Village grounds. All of Alphonso's rights are granted by the Lease; although her right to use the grounds is not exclusive with respect to her fellow tenants, it is part of her leasehold interest. We conclude that under New York law, Alphonso's right to use the grounds, shared with other residents of Castle Village and their respective guests but not with anyone else, was a property interest in the grounds.

Essentially, New York’s crazy-quilt of rights embodied in cooperative apartment corporations’s certificates of incorporation, by-laws, shares, proprietary leases and house rules, which concatenation our State’s highest court has called sui generis, and as a result of our State’s lower courts wrestling with same, equals a property right sufficient to pass the Section 165(c)(3) test for casualty loss deductibility.

While of great interest to New York practitioners, the case is of limited use elsewhere, as State law dictates property rights.

Although, the co-op form seems to be a New York thing, the common sense approach toward looking at the nature of a property interest could have broader relevance.

I was wondering a little about the case going this far given the relatively small deficiency involved. According to this story this was being used as a test case for 200 other Castle View owners. Eric Levine, the attorney handling the case indicated that it may have broad implications in the wake of Hurricane Sandy:

He said it paves the way for residents who were forced to help pay for damages at other New York co-ops the right to deduct those expenses from their federal tax returns.

The celebration at Castle View may be a little muted. The issue of whether the wall collapse was a casualty is still alive. Since the Tax Court had given summary judgment on the property ownership issue, it didn't have to get into that. Now it does.